What are the Types of Surety bonds?

The three most common types of surety bonds are: Bid Bonds Performance Bonds Payment Bonds

Are Surety Bonds paid monthly?

No. You don't pay month-to-month for sureties. When you are quoted a price for a surety bond, you make a one-time payment.

How do I apply for a surety bond?

Applying for a surety bond, no matter the sort of bond, is to contact a surety agency. For instance, you can reach CSBA here to get started on obtaining your surety bond.

What is a payment bond?

A payment bond ensures that all of a contractor’s laborers, subcontractors, and suppliers are paid on a particular project.

Who requires payment bonds?

Payment bonds are required on almost all public projects. General contractors sometimes require them of their subcontractors, and occasionally private owners will require them.

Who pays for a payment bond?

The contractor, or principal, purchases the bond and pays for it.

Do Payment bonds expire?

Payment bonds expire after the project is completed and statutory timeframe have lapsed.

What is the difference between a surety bond and a payment bond?

A payment bond is a type of surety bond. The only real difference is the qualifying term, in this case, it's "payment" and only notes what sort of surety bond it is.

What does a performance bond cover?

The performance bond covers the owner of the project against losses if the contractor fails to deliver on the project within the contractual provisions.

How long does a performance bond last?

Since performance bonds guarantee the completion of the contract, they last until the project is finished along with any required warranty period included in the agreement.

When can you release a performance bond?

Usually, a performance bond is released when the project is completed, though some public projects stipulate that a contractor gives a warranty following completion that the performance bond covers.

What is the difference between a performance and a payment bond?

We have a detailed article that explains the differences here , but the short answer is that the performance bond secures the contractor's promise to complete a job within the terms and conditions outlined at the agreed price while the payment bond protects subcontractors, vendors, and laborers against nonpayment.

What is the difference between a bid bond and a performance bond?

Bid bonds are required when contractors bid a project and guarantees if they are low bidder, they will enter into the contract and provide any required performance and payment bonds. Performance bonds guarantee the actual performance of the work to be completed by the contractor according to the terms of the agreement. What happens to a bid bond after a contract is signed? The bid bond is replaced by a performance bond if the bid is accepted and the contractor enters into a contract with the owner or general contractor.

Changes in the Surety Market

What if the surety market changed overnight, and it became much harder to get bid, performance, and payment bonds? It’s not something most contractors think about, because the surety market has been relatively stable for the past 20 years. That can make it easy to take for granted that it will always be that way. However, just like other industries, the surety market cycles, and the last true downturn was 23 years ago in the early 2000’s. That means if you didn’t own your business then or deal with bonding projects, you may not have an idea of what a “tight” surety market is like.

It’s important to remember that surety is a form of credit similar to banking. When banks tighten their lending requirements, they generally increase the financial ratios they require, require more information, ask more questions, and ultimately lend lower amounts. The surety industry responds similarly. Back in the early 2000’s, it was harder to get bonds approved, and it sometimes felt like the sureties were raking us over the coals. At the very least, this can be an inconvenience to contractors and distract them from running their business. In the worst situation, it can lead to not being able to get bonds and missing out on opportunities for work.

Where are we today

In my opinion we are at or near the peak of a cycle, meaning the surety industry could be on the verge of tightening up. Let me outline the reasons. After the downturn in the early 2000’s, the surety industry got back to basics and exhibited incredible discipline in their underwriting. As a result, the industry returned to profitability around 2004. Their discipline helped them get through the Great Recession relatively unscathed, and the industry embarked on a 20 year run of very profitable results.

The profitability of the surety industry attracted insurance companies to enter into the surety business, and the number of competitors in the market expanded dramatically. Over the past 20 years, there have been more than 20 new sureties enter the California market. Imagine if you had 20 new competitors!

When there is more competition in a credit industry like surety, the natural response is for the new competitors to lower their underwriting standards in order to gain market share. It’s similar to contractors new to a market bidding cheap to get work. The formula doesn’t end well in either scenario, but it can take time to work itself out.

One factor that enabled so many of the new sureties to enter the market is they were able to buy reinsurance fairly inexpensively with low “deductibles”. Reinsurance is insurance that sureties buy so they don’t have to absorb an entire loss. When you step back and think about it, if you can buy insurance for very little cost and almost all of the losses are absorbed by your reinsurance company, you can be much more aggressive in your underwriting – writing bigger bonds for contractors who would not have typically qualified in the past.

Parties don’t last forever

The reinsurers have essentially given the surety industry a giant punch bowl and some sureties have over indulged to the point of having significant losses. These losses have mostly impacted the profitability of the reinsurers, and after losing money for the past several years, the reinsurers are taking the punch bowl away by raising the premiums they charge to the sureties and requiring the sureties to have more skin in the game by increasing the deductibles on their policies. It is largely believed these changes will start to cause sureties to tighten their underwriting, because they can no longer afford to have losses like they could for the past decade.

These changes in underwriting haven’t been totally noticeable to us yet, but it could be a more gradual shift. If there is a shock to the market causing extreme losses, a tightening by sureties could happen more abruptly.

What should contractors do?

Howard Marks, founder of Oaktree Capital Management, has famously said, “You Can’t Predict. You Can Prepare.” In the context of contractors and their surety program this means we have no way to know when or what changes to the surety market might occur. There is a range of possibilities:

The best thing a contractor can do is work with a surety agent that will help them position their business for “all seasons”. The best surety agents don’t just try to get your next bond, they help you anticipate changing market conditions to be bondable in all circumstances. Sometimes this means not taking the path of least resistance or doing a little extra work, which can be tough when the demands on your time are great. In doing so, contractors can position themselves to not only avoid the catastrophic situation of not being able to get bonds but also to capitalize on opportunities by making your company bondable in a tough environment when your competitors may struggle.

About The Author

Dan Huckabay

President

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